Accountability: An Islamic Theory?

The word accountability is derived from the root word "account". In Arabic, "account" means Hisab. That is why accounting in Arabic can be translated as Muhasabah i.e. the process of Hisab. How about the Arabic meaning of accountability? The process of Muhasabah is ensure accountability.

There is another Arabic word Taklif which refers to that "personal accountability". In Islam, once we reach the age of puberty we are Mukallaf i.e. we are personally accountable to Allah for our deeds and misdeeds.

In Islam, there is a concept Habluminallah or our relationship with God. As human beings we have "covenant" with our creator. It means we rely on God for our existence. We are not omnipotent like God. Our "covenant" with God means we have to be accountable to God. Otherwise, the "covenant" has no purpose. On one hand we have to rely on God but on another hand we are also accountable to God.

Hablumminallah as a concept that distinguish Islamic accountability process from the Western counterpart that is purely agent-principal relationships. Islamic accountability process to God is our multidimensional and transcendental relationship to God (Hablumminallah).

On the other hand, Hablumminannass is our social relationship to other human beings. Our covenant with other human beings requires us to respect, work together, and cooperate on the basis of mutual respect and justice. Hence, we are also accountable to other human beings to ensure our covenant to other human beings is fulfilled. The relationship, in the conventional sense, is a horizontal relationship instead of a transcendental relationship.

Why are discussing all the above concepts? To me, it could help us to conceptualise the nature of Islamic accountability concepts (Muhasabah or Taklif) and relationships (Habluminallah wa Hablumminannass). Hence, it should guide us to develop "what should be" the Islamic accounting objectives that consequently guide the Islamic accounting theory to be developed.    

Is accounting a purely technical and value free discipline?

Accounting is not a science like physics as accounting rules are man-made and not the results of natural phenomena. Accounting is also not purely technical and value free discipline like computing as accountants used judgements in their works. Accounting is not merely bookkeeping and only recording of financial transactions as accountants also measures and values assets and liabilities. Accounting process also communicates financial information and interpreted by users of information, who are also human beings.

So what really is accounting?

Accounting, most likely, is a social science. The accounting rules are determined by accountants and regulators. Accountants and regulators are human beings and need to be understood. Accountants used judgements in measuring and valuing assets and liabilities. As human being, accountants are not value free. Accountants will be influenced by their background, education and some time culture. How about the religion or belief of the accountants. Will religion or belief influenced accountants' rules and judgements?

Many past studies have proved that accountants' works and judgements are being influenced by their beliefs, values or/and religion. If you are keen to know this fact you can google some of the past studies including my PhD thesis and my other papers on this subject matter. However, some studies have proven that beliefs, values and religion did not influence accountants. Could it be that human beings including accountants now are more secularised? Could it be that accountants have been trained to follow rules and used less judgements? Are accounting policies today are highly regulated and less opportunities for accountants to reflect?

On another note, in developing Islamic accounting theory, we need to explore many possibilities. One of my PhD student is trying to prove that the religiosity of Muslim accountants influence accountants' judgements. She examined the religiosity using questionnaire survey and examined the intention of accountants in potential fraudulent financial reporting. Let us wait for her findings soon.

Who said Islamic accounting theory development is purely qualitative? We can study using quantitative method on many potential accounting problems to develop Islamic accounting theory. As I mentioned in my earlier posting Islamic accounting theory can be "what it should be" (normative and qualitative) or "what it is" (quantitative and positivist). The study on the impact of religious values and culture can be done qualitatively and as well quantitatively. Methodologies do not matter. What really matter is to find the truth in whatever way possible. Are we ready?




  

Is there a theory of Islamic accounting? (Part 2)

In the previous posting, I argued that a theory of accounting can be of two possibilities i.e. what it should be and what it is. "What it should be" in a conventional methodological approach is a normative theory. We need to develop Islamic accounting theory from the sources of Islamic knowledge i.e. the Qur'an, the Sunnah, and other sources of Shari'ah. Hence, it will be hypothethical but founded on the Islamic belief system. The way to develop it might be in qualitative and persuasive way.

Islamic accounting theory needs to be founded on Islamic accountability theory. We need to distinguish Islamic accountability from the conventional counterpart which mainly centred upon the agency theory. It does not mean that the agency theory with the theorisation of agency cost and moral hazard will not be relevant, however, the conventional agency theory is argued as insufficient to explain the accountability relationship. It is superficial to only view i the context of principal and agent only. In Islamic accountability theory, we need to theorise the Islamic concept of Hamblumminallah rather than just Hablumminannass. We also need to bring in the Islamic concept of Khalifah (vicegerency), Amanah (trust) and Taklif (individual responsibility) and theorise the relationship of accountability in the Islamic way.

With the richness and very distinguished Islamic accountability theory, we should be able to theorise the role of accounting as a mechanism to ensure financial, managerial and public accountability. Modern corporations and institutions need a much more comprehensive and equitable accountability theory. Islamic accounting then will function as "what it should be" in the context of Islamic accountability relationships. We can even link the theory with the functions of Islamic financial institutions such as Islamic banks. These institutions, in theory, should be founded on Islamic accountability theory rather that the western's principal-agent relationships in the conventional sense. Hence, the Islamic accountability of Islamic institutions should in turn shape (or may be create) Islamic accounting theory.

In the next few months, my intention is to write and develop a normative theory of "what Islamic accounting should be" in the form of an academic paper. I need to spend more time to theorize the Islamic accountability from the rich heritage of Islamic concepts. I hope many aspirants PhD candidates willing to work in this area. It is dry and challenging by certainly thought provoking. May Allah SWT guide us.


      

Is there a theory of Islamic accounting? (Part 1)

Accounting theory is a difficult subject even for accounting professors. Practitioners normally avoid theory as they are too concerned with practices. For accounting students, accounting theory is a boring and dry subject. Many accounting degree programmes and professional accounting qualifications are not really teaching accounting theory. However, accounting theory is important as theory provides the foundation for practice. Sometime practices change the theory. Conventional accounting has been in search of accounting theory for more than 50 years and yet the theory of accounting (even if there is) is still debatable and developing.

In a simple term, accounting theory is an explanation and a justification of "what accounting is" and what "accounting should be". It provides a framework of thinking and principles to guide practice. Hence, Islamic accounting is an explanation and justification of what "Islamic accounting is" and what "Islamic accounting should be".

For what "Islamic accounting is", my suggestion is we need to examine the practice of accounting especially in the contemporary Islamic institutions such as Islamic banks and Zakat institutions. In theory, these institutions are guided by the Islamic worldview and the Shariah. From the study of these institutions we need to be able to derive a theory of Islamic accounting.

For what "Islamic accounting should be", my suggestion is we need to study the main source of guidance for the Muslims i.e. the Qur'an to derive some broad principles that can guide accounting practice. For example, the implications of verse 282 Surah Al-Baqarah on the accounting theory development should be studied and explained thoroughly. We also need to study the body of knowledge of Shari'ah, Usul Fiqh and Fiqh Muamalat to draw some guidances as well.

Finally, who need to initiate, study and spend their life time to undertake the above important tasks?  

Substance Over Form (Part 2)

Should Islamic financial transactions reflect the legal form or the economic substance? My honest opinion both are importance. However, for Islamic financial transactions the legal form determine the Shariah compliant of the transactions. Economic substance may seem similar to conventional but the legal form is markedly different. The previous example on Islamic investment in Islamic banks indicates just that.

Another classic example is in the case of Islamic financing. Islamic financing instruments normally revolved around the concept of buying and selling such as bai muajal, bai bithaman ajil or bai at-tawarruq. Economic substance of Islamic financing is very similar to conventional loan. The profit on loan is interest but in the case of Islamic financing it is purely profit. However, Islamic financing involved buying and selling of asset at transparent mark-up. There are contracts of purchasing and selling of assets involved. The relationship is buyer and trader as compared to conventional loan borrower and lender. Conventional loan is simply money lending with interest.

This leads to a question whether Islamic financing is like a conventional loan. From the economic substance it may appear to be similar as the flow of funds has almost the same impacts but from the legal form it is obviously not. This leads to my argument that Substance Over Form as an accounting principle cannot be adopted for Islamic financial transactions. The concept that should be used is Form Over Substance. I have discussed 2 examples already, should we discuss more....?

Substance Over Form (Part 1)

One of the most important fundamental principles of modern accounting and financial reporting is the impact of the economic substance should be reflected rather than the legal form. The economic substance reflect the purpose of the financial transaction or the economic consequences truly and fairly. The legal form is secondary important because it only accounted the legal or the technical aspect of the transaction.

The best example is when a motor vehicle company purchase motor vehicle for business purposes i.e. for sale. The substance that should be reflected is purchase of stock of goods for sale. However, if the company purchase a motor vehicle to be used by the company or by the management then the economic substance is fixed asset purchase. Even though the legal form is the same, the economic substance should be different due to different purposes of the purchases.

In the case of Islamic financial transaction, when an investor put their money in the Islamic bank let say based on a Mudarabah contract,  the economic substance is the same like conventional deposit. However, the legal form is different. Conventional deposit is a lending transaction and the bank pays the depositor interest. In the case of Islamic and Mudarabah investment, it is a relationship between the investor (Rabbul Mal) and the bank (Mudarib). The profit earned by the Islamic bank is then shared with the investor and it is not an interest payment.

From the above example, if Islamic financial transactions used Substance Over Form principle then we missed out the legal form that make up the transaction. Legal form must be reflected to distinguish the accounting treatment of Islamic investment from interest-based lending. The profit must also be distinguished from interest income that reflect the different underlying principle of Islamic financial transactions.

To be continued...      

What will be the impacts of IFRS adoption on Islamic financial institutions?

To the 2 followers of my almost `dormant blog', thank you very much. My apology as I could not update my blog as I wish to.

The above question is well anticipated in the wake of globalised international accounting standards. What are the impacts of IFRS on Islamic financial institutions? Will the adoption lead to Shari'ah non-compliant on accounting issues? To what extent our IFIs can accomodate IFRS? To what extent IFRS can accomodate IFIs accounting needs? I don't have the answers to all these questions. However, these questions needs to be asked by all of us who are concern with the development of IFIs.

For the next few months, I will be involved in a colloborative research project of MASB and ISRA on the issues IFRS and accounting from Shari'ah perspective. Definitely some of the above questions and issues will be addressed. There are a number of specific Shari'ah issues that need to be addressed such as:

1. Substance over form or form over substance
2. Time value of money
3. Fair value accounting measurement
etc.

The list is long and we need to prioritise. Crucial issue is we need Shari'ah scholars who can understand accounting and that is my challenge for this project. I will update as we go along. Hopefully, we will issue some research findings and recommendations by October 2011. Please make dua'.